There’s often confusion about who owns a limited liability company (LLC). Is it the members of the LLC, or is it the LLC managers? In this article we explore the differences between these roles and when you may want to opt to choose a member-managed LLC or a manager-managed LLC.
Who owns the LLC?
The owners of an LLC are known as members.
Think of members as analogous to partners in a partnership or shareholders in a corporation. If your LLC has managers, a member will more closely resemble shareholders and won’t participate in management of the LLC. If your LLC doesn’t utilize managers, then the members will more closely resemble partners since they have a direct say in decision making.
Management of an LLC
How does a member-managed LLC differ from a manager-managed LLC? It depends on the relationship between ownership and management.
An LLC is unique in that, by statute, it may choose one of two management structures. Either it can be managed by its members or by chosen managers (third-party individuals).
While member-management is the default rule according to state law — meaning that if managers are not selected in the Articles of Organization, the members will direct the affairs of the LLC — the LLC can state in its Articles or LLC operating agreement that the LLC is to be managed by a manager(s). This gives the manager authority to manage daily operations of the LLC, including hiring employees, issuing payments, and entering into contracts. The owners of the LLC, however, retain authority for strategic business decisions such as applying for credit, forming business partnerships, etc.
Any decision about who will manage the LLC should be made before your company begins operations. For more information, read What is an LLC operating agreement and why do you need one.
A member-managed LLC is a business entity in which all members participate in the decision-making process. Each member has an equal right to manage the LLC’s business, unless otherwise stated in the operating agreement. If a dispute arises, the vote of a majority generally rules. Although certain actions can require unanimous consent.
If the members consent, an LLC may be set up with different classes of members with one class having greater or different management rights than others.
Reasons to choose a member-managed LLC
While each situation is unique, the following scenarios may prompt you to choose that your LLC be managed by its members:
The members wish to play an active role in day-to-day management.
The LLC only has a small number of members and basic management decisions can be made without consulting other members.
The members are familiar with the business and able to make informed decisions.
Rights and responsibilities of LLC members
LLC members have some key rights and responsibilities, including:
- Financial rights: Members have certain financial rights, such as the right to share in allocations of the company’s profits and losses. They can also share in distributions of the LLC’s assets. The operating agreement will set forth the precise nature of those financial rights, such as whether they are shared equally, based on capital contributions, or some other criteria. It’s important to note that although members manage the business and its affairs, they do not own the LLC’s property.
- Right to vote: The scope of a member’s voting rights depends on whether the LLC is managed by its members or by managers. In a member-managed LLC, members can vote on all matters that affect the business and its affairs. In a manager-managed company, members have limited voting power. All voting-related rules such as meeting locations, requirements to quorum, etc. should be included in the operating agreement.
- Member inspections: Some states require that LLCs maintain certain records and provide the right for members to inspect these records. Records include the names, addresses, contributions, and shares of profits and losses of each member. They also contain the names and addresses of managers and certain tax records. If your LLC wants to restrict or expand a members’ right to inspect these records this can be stipulated in the operating agreement.
- Liability of members: A key characteristic of an LLC is that members are not liable for the company’s debts or obligations. However, members are obligated to make required capital contributions. Any penalties for failing to do so are set forth in the operating agreement.
What if the LLC has one owner (single-member LLC)?
Many small businesses operate as a single-member LLC, meaning they have one member or owner. In many cases, single-member LLCs opt to be member-managed. For federal tax purposes, a single-member LLC is a “disregarded entity” and still has asset protection. Business income and expenses are reported using Schedule C and carried over to personal IRS Form 1040.